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Blockbuster Misses Profit Estimates

27 Oct, 2004 By: Holly J. Wagner

Blockbuster Video is spending more money faster than executives expected on its new initiatives in a gamble that consumers will embrace the chain as a hub for subscriptions, trading and games as a replacement for its sliding core rental business.

In a separate announcement, the company said president and COO Nigel Travis has resigned and will leave the company at the end of the year. Antioco said he would be more closely involved in the business in the wake of Travis' departure, which he said owed to Travis' desire to be a CEO.

The chain missed profit estimates by a wide margin for the third quarter on greater-than-expected expenditures on new initiatives and a continuing slide in rentals.

But the big surprise in the company's third-quarter financial call is changes to the “integrated” subscription plan promised for next year. In previous calls, executives offered sketchy information on how a merged online and in-store subscription system would work, but in the most recent call they seemed to change course, saying the chain might never offer consumers one subscription that would apply in both the physical and virtual worlds.

“We are going to be using our stores to ship product, so that when a customer orders a movie, it will be shipped from the closest Blockbuster store to the customer, and the return envelope will reflect that,” CEO John Antioco told analysts. “We have not made a final decision as to whether or not we will offer a totally combined program that will let people rent online and in-store interchangeably. What we are seeing right now is that we are getting the lion's share of the benefits of integration.”

Blockbuster Online is gathering 10,000 new subscribers a day, Antioco said. While he did not address churn, he did say that “more than half of our online subscribers have not shopped in our stores in the last 12 months.”

The company has offered two coupons for free in-store rentals each month with online subscriptions. After Netflix dropped its price from $21.99 to $17.99 per month, Blockbuster followed with a drop from $19.99 to $17.49 per month and sweetened the pot by extending the monthly coupons beyond movies to include games. Antioco said the coupon redemption rate has been very high and the company now plans to offer coupons for retail and used products.

“The coupons are a net positive,” Antioco said, noting most people spend in addition to the coupon when they go to the stores.

“The question is, can we make money at $17.49? The answer is yes. We did not expect to make money online this year and next because of our investments,” Antioco said. Those investments will reach $120 million by the end of the year, half of which is subscriber acquisition and marketing costs. Blockbuster had expected to spend $90 million. The company also plans to double its distribution centers to 20.

Wedbush Morgan analyst Michael Pachter said the coupons may be enough integration to satisfy consumers.

“Somebody in their marketing department had the brilliant idea of these two free coupons,” he said. “What happened was, they found that people really liked that.”

“This is a disguised way of charging people $18.49 instead of $17.49 … I think what they are thinking about is that maybe if we give people more coupons — if you drive the consumer into the store — they spend more when they are in there,” Pachter said.

Regarding the other new initiatives — games and in-store trading — Antioco said the company has opened 400 Game Rush stores in the United States so far and should have 450 by year's end, and that most of the new stores planned for next year will be freestanding game units.

In trading, he said the chain is seeing high sellthrough on titles consumers bring in to trade. In addition to having 4,000 corporate and franchised stores in the United States offering trading now, Big Blue expects to add another 1,000 stores to that tally by the middle of next year. Executives did not mention the 40-plus Movie Trading Company stores it has open in Texas, Utah, Colorado and Georgia.

Including a $1.5 billion third-quarter non-cash charge on goodwill and charges related to the spin-off from Viacom, the chain posted a net loss of $1.42 billion for the third quarter ended Sept. 30.

The company's 2 cents per share profit on adjusted net income of $3.4 million was well below the 9 cents analysts expected. Total revenue increased 1.8 percent, to $1.41 billion for the third quarter, from $1.38 billion for the third quarter of last year. But the non-cash charges of $1.5 billion to impair goodwill and other long-lived assets resulted in a net loss of $7.84 per share.

Same-store revenue was down 3 percent and worldwide same-store rental revenue was down 6.3 percent. Domestic same-store rentals were down 7.4 percent. CFO Larry Zine blamed the Olympic Games and a weak release slate for the rental fall.

Antioco and Zine said guidance for the rest of the year is “irrelevant” in the wake of the spin-off and also did not offer any guidance for next year.

The company recorded a $1.42 billion charge, or $7.82 per share, because of the stock-exchange offering with Viacom.

Executives expect same-store revenue to slide into the low-single-digit percentages for the fourth quarter, in part because Christmas and New Year's Day both fall on Saturdays.

They also expected strong sellthrough and less rental appeal for fourth-quarter blockbusters Shrek 2, Spider-Man 2, Harry Potter and the Prisoner of Azkaban and The Bourne Supremacy.

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